Watch out for the inner workings of your bank's credit card policy. (Thinkstock)

December 17, 2013

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If you have a credit card or a checking account from a big bank, odds are that somewhere deep in the agreement you signed there's a clause that says you agree to waive your right to sue the bank if you think they have somehow violated the account agreement or otherwise harmed you.

A report issued this week by the Consumer Financial Protection Bureau suggests that big banks may be using arbitration clauses to tilt the playing field against individual consumers. And financial services firms are worried that the CFPB report signals the agency's intent to impose new restrictions on the industry.

This section of the contract in question is called the "arbitration clause," and it bars consumers from taking the card issuer to court. Instead, any dispute must be settled through arbitration — meaning the cardholder and the card issuer meet with an impartial third party who issues a ruling on the dispute.

The use of arbitration clauses is typically seen as a way of reducing costs from frivolous lawsuits, and in cases where a complaint has merit, of settling a complaint more quickly and avoiding costly litigation.

Among other things, though, the CFPB found that arbitration clauses were typically far harder to understand than the other elements of the contract, that a large portion of consumers involved in arbitration proceeding have no legal representation, and that the contracts typically bar consumers from pooling resources to come to arbitration as a class.

"Opponents argue that arbitration clauses deprive consumers of certain legal protections available in court, and may serve to quash a dispute rather than provide an alternative way to resolve it," said CFPB Director Richard Cordray in remarks at a field hearing in Dallas last week.

He said, "Today's preliminary results help us better understand how these clauses are affecting consumers' financial lives so that we can ultimately determine whether action should be taken for their greater protection."

In a report issued by CFPB, the agency examined the arbitration clauses from 66 credit card and checking account contracts from various companies, and rated them according the Flesch-Kincaid grade level scale, a widely accepted measure of readability.

The agency found that the majority of the Arbitration clauses were written at a level that a college student could be expected to understand. This made them substantially more complicated than the other sections of the contract, which were written at a 10th-grade reading level.

The agency found that in arbitration cases, nearly half of consumers (47 percent) are not represented by counsel, and in arbitration cases related to debt collection, 58 percent have no legal representation. By contrast, it found, the financial services firm is practically always represented by inside counsel or a hired firm.

Ninety percent of arbitration clauses bar consumers from joining class arbitrations, which would allow them to concentrate their resources in order to hire representation.

The CFPB report is a preliminary finding that is part of a broader look at arbitration clauses mandated by the Dodd-Frank financial reform act. The agency is continuing its investigation in advance of issuing a report to Congress.

An agency spokesperson said the CFPB is a long way from deciding whether to issue new rules. "We haven't drawn any conclusions and we haven't made any proposals."

But that hasn't stopped the financial services industry from worrying.

Alan Kaplinsky, an attorney who was at the forefront of the use of arbitration in financial services contract, told American Banker that a major change was practically a foregone conclusion.

"The CFPB seems to be setting the stage for a rulemaking which will likely not be favorable to the industry," he told the paper. "While they claim not to be prejudging the ultimate outcome, their findings seem to be designed to support a conclusion that arbitration is inhibiting consumers from vindicating their rights and that class actions are necessary."

Gilbert T. Schwartz, a longtime banking attorney and principal of the firm Schwartz & Ballen in Washington, said that it was unusual for the CFPB — or any agency — to issue the preliminary results of a study requested by Congress.

"Why are they doing this? Maybe they are trying to test the waters and see what kind of reaction they get," he said. "Maybe they want to see what's going to happen on [Capitol] Hill."

Schwartz pointed out that one of the primary questions that will be raised if the CFPB does proceed with a rulemaking will be whether the agency is right on barring a practice within the financial services industry when it is still considered acceptable in other consumer contracts?

"If they are bad, they are bad for everybody," he said. "Not just for the financial services industry. Isn't this really an issue for Congress to consider?"